April 18th, 2014
Los Angeles Daily Journal
Early Sullivan partner Stephen Ma was invited to write an article titled “Can crowdfunding handle success?” by The Los Angeles Daily Journal. Ma’s article appears in the paper on April 3, 2014.
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Can crowdfunding handle success?
By Stephen Ma, Early Sullivan Wright Gizer & McRae LLP
Oculus VR, recently acquired by Facebook for $2 billion, is arguably the biggest success story in crowdfunding’s short history. Oculus is a virtual reality company, based in Southern California, which raised over $2.4 million in 2012 via Kickstarter. The $2.4 million came from thousands of supporters pledging from $10 to $5,000, or more. The individuals pledging funds received a variety of items, including Oculus posters (for a $15 pledge), T-Shirts (for $25), prototype products (for $275), and visits to Oculus’ headquarters (for $5,000).
One might think that Oculus’ supporters would be tickled pink when learning about the $2 billion acquisition by Facebook. The positive reactions to the acquisition, however, were countered by a significant amount of negative feedback from Oculus supporters objecting to the deal:
There does not seem to be any dispute that these pledges were donations to Oculus, rather than equity or loans. But many of those objecting to the $2 billion acquisition contend that it was somehow unfair to Oculus’ Kickstarter backers, despite the fact that these backers did not have any ownership rights or contribute to Oculus’ operations or management in any way. As a lawyer who has been involved with both start-up companies and securities litigation, I suspect that some enterprising lawyers are now investigating possible ways to bring a lawsuit against Oculus and/or Kickstarter. Regrettably, recent news reports have even confirmed that Oculus employees have received death threats.
What exactly is the cause of all this controversy? President John F. Kennedy once said: “Success has many fathers, while failure is an orphan.” Despite disclosures by Oculus and Kickstarter that these pledges are donations only, many of these backers apparently view themselves as Oculus “investors,” who deserve to be compensated. Perhaps many of these early supporters now realize how much money (e.g., billions) is involved with recent acquisitions such as Oculus ($2 billion), Nest Labs ($3.2 billion) and WhatsApp ($19 billion).
The problem is that many supporters of crowdfunding apparently do not realize (or refuse to acknowledge) that the so-called “New Economy” is still governed by wellestablished legal authority. For example, Kickstarter backers cannot sue for breach of contract when there is no written or oral agreement to provide ownership or other rights to the company. They cannot sue for breach of fiduciary duty when the company has made clear that the Kickstarter backers are not fiduciaries. They cannot sue for securities fraud or any other type of fraud absent a showing of, among other things, fraudulent intent, material misrepresentations, or material omissions.
Another problem is that some of these early backers seem to equate their emotional “investment” in the company with some legal or equitable stake. In the course of my work, clients often ask me why lawyers insist on written documentation when there is “no way” anyone could misunderstand or dispute the terms of an agreement, a transaction, or the management of a company. Typical questions include: Why do we need an operating agreement when the founders of the company can make decisions as we go forward? Why do we have termination provisions when we just started this company? Why do we need to make all of these disclosures when everyone understands that these are only donations?
The answer is simple: Money changes everything.
Stephen Ma is a partner with Early Sullivan Wright Gizer & McRae LLP.
Source: Los Angeles Daily Journal